Crude oil prices had a positive week (10/07/2017 – 16/07/2017) with supportive inventory figures on the back of sustained demand (see Exhibit 1). However, we expect this rally to be short-lived for several reasons. First, on the supply side, US shale producers are acting as a cap to any upside for prices, pumping more oil as prices rise, while at the same time, improving technology (e.g., better drilling heads, data management) is driving down breakeven prices, allowing for profitable production at a lower cost. Second, the ability of the OPEC producer cartel to sustain prices through production cuts appears to be reaching its limits. The latest International Energy Agency figures showed OPEC member compliance with production quotas had decreased.

Exhibit 1: US crude oil – days of supply

Source: DOE, BNP Paribas, as of 17/07/2017

Not a happy blend: budget pressures and production cuts

In part, this could be due to the pressure that production cuts are putting on the fiscal balances of the main OPEC producers, including Saudi Arabia. Indeed, the cuts are hurting their revenues without having the expected impact on oil prices: despite the current agreement on production cuts, spot prices have remained relatively low and on the forward market, future contracts are trading at above spot prices, benefiting those US shale producers who hedge their production by selling oil a few years forward. Arab Gulf countries typically sell their production at spot prices. Looking at the forward market curve, one can see that the OPEC cut had an impact in January 2017, but this has now been reversed, with the curve now similar to where it was a year ago in 2016.

Exhibit 2: Crude oil forward curve (WTI)

Source: BNP Paribas Asset Management, as of 17/07/2017

Back to a battle for market share?

This could raise doubts about the efficiency of a production cut and keep OPEC countries from renewing the agreement. Instead, a battle for market share could flare up involving the ‘opening of the taps’ and raising production.